In the competitive spirit of college basketball's annual championship tournament, The Motley Fool brings you Stock Madness 2007! Our writers are making head-to-head arguments for their chosen stocks (but not necessarily investment recommendations -- this is, after all, a game), and you'll pick the winners with your article recommendations and Motley Fool CAPS ratings. Who will win the right to cut down the net? Let's tip things off and find out!
I root for the underdog. I hope you do.
Sleep Number mattress-maker Select Comfort (Nasdaq: SCSS ) goes up against biopharmaceutical giant Gilead Sciences (Nasdaq: GILD ) in the first round. Despite its recent change of expectations, I think Select Comfort has all the tools to be a giant-killer.
A championship run?
Before you think I'm crazy -- after all, Gilead recently generated more than $1 billion in free cash flow and is growing at around 70% per year -- read carefully what I write. Growth is great, but big investment returns come from buying growth at bargain prices. Select Comfort offers both. Gilead, in my opinion, does not.
Think of it this way. The company ended its regular season on a whimper but has the tools to regroup and make a run for the championship in March, as expectations that were too high before have become too low now. That creates the perfect storm: growth at bargain prices.
The catalysts for growth
First of all, Select Comfort has a great position in the mattress industry. Sealy's (NYSE: ZZ ) spring mattresses are nice, and Tempur-Pedic's (NYSE: TPX ) foam-based products are very comfortable (I love the pillow I received for Valentine's Day). But a Select Comfort bed is the only one that can adjust to the needs of every customer. That Sleep Number creates a huge positional advantage.
Competitive advantage requires a good position as well as the right supporting capabilities. That's why, as the business grows and changes, management invests in sales, marketing, and operational improvements. The latest investments in sales, ERP systems, and distribution should help increase sales and margins in the future. Recently, the company plugged a big hole and hired Shelly Ibach as its U.S. retail channel leader. She'll help strengthen the capabilities Select Comfort needs to support its positional advantage.
Here's why it's cheap
Let's get this out of the way: Select Comfort generated less cash flow in full-year 2006. One reason was that the company increased the number of retail partner store opportunities to 822 from 353. Companies like Mattress Firm and Berkshire Hathaway's (NYSE: BRK-A ) (NYSE: BRK-B ) Nebraska Furniture Mart don't pay in cash. They pay using credit, causing accounts receivable to increase. In addition, customer prepayments were down and SG&A spending was up.
From this lower level of free cash flow, growth expectations built into the current stock price are only about 15% over the next 10 years. Given that the company's competitive position should help it take market share while generating great returns on invested capital, I think free cash flow growth can exceed those expectations.
I'm not the only one who thinks the stock is cheap. Management repurchased almost $70 million of stock (net of new issues), and I think that is a good allocation of capital at depressed prices.
What do you think? Do I have a growth-at-bargain-prices giant-killer on my hands? If you agree, help me get to the next round by following this link and rank the stock "outperform" in Motley Fool CAPS. If not, vote it "underperform." Later this week, we'll tally your votes to determine which stocks will advance one step closer to the title.
Click Gilead Sciences to read the opposing entry in this contest and click here to read all of the tourney articles.
Do you think you could pitch your favorite stock or ditch your least favorite one in less than 27 seconds? That's what we're doing over at Motley Fool CAPS. Check out our new stock videos.
Select Comfort is a Motley Fool Hidden Gems recommendation. Berkshire Hathaway is an Inside Value selection.
Retail editor David Meier thinks he gained an investing advantage at Wake Forest. He does not own shares in any of the other companies mentioned. He is currently ranked 428 out of 24,208 investors in the CAPS rating service. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.
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